Energy costs, labor costs, insurance, packaging, interest rates. The cost of everything has increased in the past 17 years, but the assumed processing costs in the Federal Milk Marketing Orders (FMMO) haven’t changed.

The industry is in the process of updating processing costs, called make allowances, but with the way the US pricing system is constructed, higher make allowances mean lower minimum milk prices, which farmers obviously don’t like.

FMMOs

First, let’s talk briefly about how milk is priced in the FMMOs. If farmers had to negotiate a daily selling price for their milk they would persistently be at a disadvantage due to the perishable nature of milk. Instead of trying to find a market price for milk the FMMOs currently use end-product price formulas.

The US Department of Agriculture (USDA) surveys dairy plants to find out what price they are selling basic dairy commodities (cheddar cheese, butter, dry whey and nonfat dry milk) for. Then a set of formulas is used to convert the value of the dairy commodities back to the value for the milk that went into those dairy products. This is how the Class I, II, III and IV milk prices are determined. Those are the minimum prices that dairy processing plants have to pay back to the farmers, although they can pay more if the supply of milk is tight or agreements have been made to pay premiums based on quality, consistent weekly deliveries or other reasons.

Probably the most contentious part of those milk price formulas is the make allowance. That is the portion of the revenue from selling bulk commodities that dairy processing plants get to keep to cover the cost of converting raw milk into those commodities. The last time make allowances were changed was in 2008, and that was based on cost surveys done back in 2005/2006. It is a long and involved process to update the FMMOs, so the industry has avoided it until now.

So what should the new make allowances be? In the past the industry has relied on voluntary surveys to try and find an average cost of processing the different dairy products. A survey was recently done again and found that costs were up about 45% for making cheese and dry whey while the cost of making butter and nonfat dry milk were up a whopping 71% compared to the current make allowances.

The cost of processing

Previously, the state of California calculated the cost of processing basic dairy commodities every year using audited data from the dairy plants in California, but it stopped doing this when California switched from a state-run marketing system to a FMMO.

The International Dairy Foods Association (IDFA), Washington, DC, also asked Dr. Bill Schiek from the Dairy Institute of California to extrapolate the most recent California processing costs to an estimate of current costs using various inflation indicators. His analysis suggests the cost of making cheese and dry whey was likely up 48% while butter and nonfat dry milk was up about 51% compared to the current make allowances.

Currently, a cheese plant gets to keep $3.17 per hundredweight (cwt.) of milk it processes to cover its processing costs, but Bill Schiek’s estimate is that actual costs are currently closer to $4.72. If the USDA were to adopt these higher make allowances, it would reduce the minimum Class III milk price by $1.53/cwt. and it would reduce the minimum Class IV price by $1.10/cwt.

That is a large and sudden reduction in milk prices for farmers, so higher make allowances will likely be phased in over time. While the exact magnitude of the change, and the timing of the change are unknown, a change is not likely before January 2025.

Editor’s note: This material should be construed as market commentary, merely observing economic, political and/or market conditions, and not intended to refer to any particular trading strategy, promotional element or quality of service provided by the FCM Division of StoneX Financial Inc. (“SFI”) or StoneX Markets LLC (“SXM”). SFI and SXM are not responsible for any redistribution of this material by third parties, or any trading decisions taken by persons not intended to view this material. Information contained herein was obtained from sources believed to be reliable, but is not guaranteed as to its accuracy. Contact designated personnel from SFI or SXM for specific trading advice to meet your trading preferences. These materials represent the opinions and viewpoints of the author, and do not necessarily reflect the viewpoints and trading strategies employed by SFI or SXM.

 – Nate Donnay is the Director of Dairy Market Insight at StoneX Financial Inc. He has been applying his expertise in large complicated systems and statistical analysis to the international and US dairy markets since 2005.